September 23, 2005

The Rural Employment Guarantee Scheme (REGS) has the word guarantee in it and whatever else it may or may not guarantee, it certainly guarantees greater overall poverty than would be the case without the REGS.

In brief, REGS does not increase the aggregate production of the economy, nor does it increase productive capacity; it merely redistributes incomes by giving money to those in the rural areas. The first order effect of this diversion of resources is that other projects which have the potential to increase production and increase productive capacity do not get done; that is, the opportunity cost of the REGS is very high. The second order effects are increased public corruption, making the population much more dependent, increasing population, etc. This means in the future, the economy will produce much less than it would have otherwise produced and thus more people would face poverty as a result of the REGS .The rest of this essay is an elaboration of this argument.

Reasoning from the basics, first we must understand what the words poverty, income, employment, and production mean and how they are related to each other. Given the widespread confusion of these basic words, it is not surprising that the reasoning comes out all warped and some rather silly notions are entertained by supposedly sane people.

Poverty is lack of income, fundamentally and essentially. Income is real and is not to be confused with money which is nominal. The confusion between income and money happens because income is denominated in money terms. One can have income without having money. For instance in a Robinson Crusoe economy, Robinson’s income is what he gathers from the forest and the sea, farms and manufactures through his labor. Income is the real stuff that he can eat, and wear, and save. The seeds he saves for the next season’s plantings are his investments. Whether Robinson is poverty stricken or not depends entirely upon how much stuff he produces through his labor, and what he gets without having to exert any labor such as coconuts falling of their own on his head.

A Robinson Crusoe economy is a simplified model of a real economy. In the RC economy, there are natural resources such as the ocean and forests (land), Robinson’s ability to do work (labor), a few tools (capital), and Robinson’s knowledge of how to do things such as making a fire, planting corn, making bread (technology). Robinson is the capitalist who owns the means of production. He supplies the labor, and he gets paid wages which are his income. Depending upon how good his technology is – such as knowing when to plant what, or how to make a fishing net; and how much labor he supplies – or how much leisure he enjoys; and how much of his income he consumes and how much he saves for future investment; and how good his tools are, all add up to a steady stream of stuff that is available to him and that is his income. If the amount of stuff he produces plus what nature gives to him without his exertions is below a certain level, he is poverty stricken.

Robinson could be fabulously wealthy without ever lifting a finger if nature provided all the goods he needed. That is, he would be totally unemployed and still not be poor because he would have an income without so much as moving out of his hammock. On the other hand, he could be toiling day and night and be fully employed 24/7 and yet produce so little stuff that he lives in dire poverty. You could be unemployed and rich if you get gifts, or you could be employed and yet be poor if you produce too little. To conclude this bit, poverty is lack of income, and income is stuff that you get to consume – whether it was produced by your labor or not.

Now getting back to the real economy, you have one major difference with the RC economy: the real economy has more people. All other bits remain the same. Income to a person then is that person’s share of the total amount of stuff produced in the economy. How he is apportioned his share of the total production of the economy – that is his income – is a matter that is determined by various factors. For example, he could own machines, which other people use to produce stuff and in exchange they give him some of the stuff produced. He then is a capitalist and enjoys an income without working. He is “unemployed” but not poor. Or he could be a laborer who works in a farm and gets to keep what he produces, or he could be a programmer and gets paid money which he uses to buy stuff. Or he could be just a bum and the government gives him a handout every month.

So here is absolute bottom line: people are poor when their incomes are below a certain level, irrespective of whether they are employed or not, whether they have money or not. Now the reason that a person’s income is low could be because the economy as a whole produces too little relative to the number of people among whom the production has to be distributed (the production-population imbalance), or it could be that the economy produces a huge amount of stuff but the person for some reason is unable to receive his fair share of the production (the production-distribution imbalance.) Of course, you could have combinations of the above two to get inadequate production coupled with poor distribution.

Just to underline one point that we need to keep in mind: no one, including me, wants employment; we want an income. Employment is a means to the end—the income—and not an end in itself. If we did not have to be employed but received an income, we would be free to enjoy leisure in which we could do what we pleased, from programming computers to raising corn or digging ditches. I would be happy to let robots create all the stuff that I need so that I can spend the entire time eating with nice people, drinking with nice people, and sleeping with nice people with a contented mind.

So far we have been trying to get the vocabulary straight. Now that I am done with the vocabulary bit, we can start to reason about the problem with REGS.

India has a poverty problem because some people have incomes far below what is considered adequate for a decent human existence. It is not an employment problem, it is an income problem. Guaranteeing employment when the actual guarantee should be income is asininity of degree one.

How one goes about solving a problem depends on the nature of the problem. Is the enormous poverty in India due to the production-population imbalance (too many people, too little stuff produced) or is it due to the production-distribution imbalance (enough stuff but badly distributed)? Let’s do some arithmetic.

India’s per capita production per year of stuff denominated in money terms is US$500 or so; that is, between a dollar and two dollars a day per head. (Let’s not go into the PPP measure of income which needlessly muddies the matter; it requires a separate chapter to fix that confusion.) Clearly India suffers inadequate aggregate production because even if that was distributed perfectly evenly, each one of the more than billion people of India would be desperately poor. While maldistribution of this inadequate aggregate production seriously compounds the problem that the poorest face, clearly the more fundamental problem is that India just does not produce enough for the population that it has to support.

Indians are poor because India’s aggregate production is inadequate and therefore the solution has to begin with increasing production. Let me repeat that: we don’t need increased employment; we need increased production. And only after having produced more, we need to distribute that production better so that those who have little income can get more. Any policy which increases employment and which decreases aggregate income is therefore the most insane policy that an economy can have. It is my contention that the REGS increases employment and decreases aggregate income. And that will lead to increased poverty, as I argue below.

The REGS aims to increase employment alone and is not aimed at increasing either production or production capacity. The REGS terms state that laborers cannot use any labor saving devices if they are being paid under the scheme. Basically, if a large hole needs to be dug, you could employ one person to use a mechanical shovel and do the job. Or you could have 100 people use hand-held shovels and do it. Or you could employ 1000 with tablespoons, or 10,000 people with toothpicks to do the job. In the end only one hole gets dug but you employ more people. If by digging the hole we increase our aggregate production of stuff by Rs 1000, then the income from the employment per capita is Rs 10 per shovel-wielding worker, Rs 1 per person with a tablespoon, etc.

If the REGS does not increase the amount of stuff produced, then it essentially is an income transfer scheme. If the economy was already producing what it needed to produce, and all it needed was proper distribution of the production, then an income transfer scheme is great. Otherwise, it is better to use the labor to increase production and use the increased production to raise the incomes of those who are poor.

If there are projects that are worthwhile – that is, they increase the production of stuff or increase the capital stock – then these should be undertaken and the labor needed employed. I take it for granted that India has such projects, from building the infrastructure to educating its masses. Resources are required for these projects. The opportunity cost of diverting resources (around Rs 50,000 crores, or $10 billion a year) to schemes that essentially produce nothing nor add capacity is the value of projects that will not get done as a result.

For $10 billion, for instance, you could educate the hundreds of millions who need basic literacy and numeracy. There are enormous benefits to doing this which otherwise don’t arise when you are merely using labor to dig holes in the ground using bare hands.

There are other insidious effects of the REGS. First, it makes the people dependent on the government. Everyone cannot live on handouts – someone has to produce stuff. Handouts depress initiative and drive. Second, it increases the opportunities for bureaucratic and political corruption. Third, sets a precedent for political parties to continue to make irresponsible promises to people to win elections. Fourth, it will compound the population problem because increased incomes at the subsistence level increases fertility.

In conclusion, the economy needs to produce more stuff if it has to lift people out of poverty. Stuff gets produced by intelligently combining land, labor, and capital on projects that are efficient and have strong backward and forward linkages. Digging holes in the ground bare handed does not make any real difference. The REGS guarantees further poverty.

Post Script: The scheme is variously called National Rural Employment Guarantee Scheme (NREGS) and Rural Employment Guarantee Bill (REGB). Amit Varma had earlier posted on this blog his article on REGB in the AWSJ.

I more or less agree with your reasoning. But what if the REGS is used to build infrastructure – in rural areas – I believe that is the intention of the government.

The REGS says that work has to be done on housing, irrigation, rural connectivity. I agree that production capacity has to be given priority – not employment. Employment increase will be natural result of production increase.

But in rural areas – private sector is reluctant to invest due to lack of infrastructure. More so is the case of rural infrastructure – the private sector avoids getting into infrastructure build-up in rural areas due to the supposedly ‘low returns’.

Is it not possible that the REGS will ensure that infrastructure is built – thereby attracting investment in production capacities and thereby generating sustainable employment.

Free markets are good but in areas where free market fail – someone has to interfere. Otherwise the social costs of waiting for the so-called ‘long-run adjustment’ are too high.

Thought-provoking piece. One pro-REGS argument could be that this is one way of jump-starting the economy, to some extent. As in, if this money lands up in the hands of these rural types, they will use it to buy food, soap, 5-Star bars and so on and in some sense stimulate overall production. Or would you argue that since this is an income transfer from one segment to another, the aggregate demand would be the same, and so there really wouldn’t be any net increase in production, because there would be a fall in demand in some other sector of the economy?

Here is another thought: How about just printing the money and giving it to the people eligible for REGS? The standard argument is that this is a nuts idea, because it will lead to inflation, but that is when there are supply side bottlenecks (are there?). Wouldn’t that work as well, to some extent, if managed correctly? Of course, this would appear to be like walking on economic eggshells. This has apparently happened at a microcosmic, and tragic/farcical level already in Bhopal. For some period, after the gas leak victims received compensation, the retail market in consumer durables boomed. Things are more moribund now, I think.

Finally, I’m not sure if the “REGS leads to corruption” argument holds. Wouldn’t that be true of _any_ spending on this scale? Why wouldn’t the same hold for building IT parks, a flyover, an aircraft carrier, something as stupendously useless as a metro system for Delhi or Bombay, an airport and so on? This was brought up in an article I read recently, not sure where. It appears that corruption is OK in some cases, and not acceptable in others.

Anyway, just random thoughts. I am not an economist, so pardon the insanity :)

1. Employing people is not productive (in the sense of increasing the output of goods and services)? “Let me repeat that: we don’t need increased employment; we need increased production” I am not sure how you can argue that. Remember, it’s not an income scheme, it’s an employment scheme. As long as unused resources are being used, we can move closer towards a production possibilities frontier (another story from intro to econ). There is a caveat: if resources taxed by the government to pay for the employment guarantee scheme were going to be more efficient or productive, there could be a loss in output. But you haven’t shown any proof that the $10 billion would have been used more efficiently. What are the kinds of things that REGS will be used for- irrigation projects, infrastructural projects and so on- these could be genuinely productive. Even if it is the case that there is a net loss of output, using your Robinson Crusoe example, what is happening in that case is that Robinson Crusoe is giving up some of his surplus so that Man Friday (almost always forgotten in RC stories) can work, produce some output (perhaps not as much as RC could) and help his family survive. Maybe Man Friday cannot wait till RC has enough before redistributing.

2. The REGS is not efficient (because no labor savings devices are allowed). Ok. We can discuss the production technology, but it’s certainly unlikely that this will be implemented in force. Do you think that the bill really prevents the use of, say, spades? If so, yes, it’s a bad scheme, but I simply don’t think this will be the case in practice.

3. Government creates dependency. I’ve been educated in a public institution. That means someone somewhere has paid for me to get my education. I am not sure that it has created in me a sense of dependency on the state, but rather it has helped me engage more fully with the potentials open to me. I hope that we can grant that the same could be true of jobless farmers. Perhaps at an even more fundamental level, the opportunity to work in a dignified manner and have some security will allow there to be greater ability to undertake other activities. BTW, lest it not be said, we are all dependent (usually) on some institution or another (firms, governments, NGOs), and so on. Losing an opportunity for employment is usually calamitous, but especially so if you are really on the margin.

4. Corruption etc. Yes, true, and something that needs to be monitored. But there is the potential for corruption anywhere, even in the private sector and in other things as pointed out by Ludwig.

5. You make a perhaps inaccurate argument- providing rural folks with income will only make them produce more babies. There is a literature, of course, that children can be seen as social insurance (yes, I know its contested). If that is the case, having other forms of social insurance can, in fact, reduce population. Not that I want to get into social engineering of demographics at the moment.

I have little or nothing to add to what you say—you have explained the problem with employment guarantees better than any other source I have seen on the subject.

Unfortuntately, governments appear to have little incentive to adopt policies to increase productivity by letting people internalize risk, as they capture rents from opportunities for bureaucratic and political corruption. (Check out the US govt bailout of New Orleans to the tune of $200b if you want an example of the problems w/free govt insurance from this side of the world).

You clearly explain how this employment guarantee kills initiative and drive, thereby strangling the “goose that lays golden eggs” and ensuring these guaranteed jobs will pay little real income. Unfortunately, that which seems an obvious folly to you looks like a politically popular free lunch to the average citizen, while the policy of internalizing risk and reward, which might provide the incentives for increased real income, sounds hard-hearted.

Well, there is a glitch in your views.
increasing employment is crucial. You talk about digging a hole, but i would talk about constructing a road to enhance rural connectivity. Whe these workers are employed to improve the rural infrastucture, it is increasing the productive capacity of that particular village. When the workers start earning wages, their demand increases, which acts as an incentive for producers/sellers to start up stores there.
But, employement creation cannot solely reduce poverty. It needs to be supported by educational programmes and health programmes. No programme will be a success without the help of supporting programmes.

I know that I am quite the late entrant to this discussion (nearly two years late!) but I am a new reader of this blog and I happened to chance upon this post. I have some points I would like to raise on the issue, and I do hope that others will respond to some of my points.
1.”poverty is lack of income, and income is stuff that you get to consume”
You are equating income with current consumption here, which is wrong, because it leaves no room for savings. People might save to consume in the future, (savings and hence incomes might thus become a form of consumption) but people might also save simply to hoard or simply because their current consumption needs are met and they have nothing else to do with the excess incomes. In saying that incomes equal consumption, it implies that a miserly crorepati and a spendthrift lakhpati who both have the same consumption patterns have the same incomes.
Because you have confused the two issues of income and consumption together, you reach a conclusion to solve poverty that I am opposed to. Incomes = consumption, and therefore we reduce poverty by increasing the stock of consumable goods by boosting growth and industrial production. Income must be thought of as an empowering concept, wherein a person with increased incomes has greater security and a chance to develop a better way of life, and not necessarily simply a proxy for consumption.
Basically you argue a “trickle-down” approach to solving poverty where I advocate a “bottom-up” approach. What if, in increasing growth and production, we employ larger amounts of capital as opposed to labour? The increased value of production (which let us say finds a fulfilled market in the richer middle and upper classes) and the rewards to owners of capital might serve to increase per capita income, but the rewards to the poorer labouring class might not increase in the same proportion. Which brings me to another criticism: you have neglected distributional aspects of the problem. I do not have the links on me right now, but I have read reports which say that inequality in Inida has increased along with increasing per capita incomes. To me, this is definitely not a desirable goal.
2. The NREGA defnitely does not advocate digging empty holes. Its aims are to develop rural infrastructure through the use of labour-intensive technology, simultaneously fulfilling the aims of infrastructure development in the rural sector where private investment has been lacking and allowing maximum number of labourers to receive some form of employment. Whether it is properly achieved is a different matter, a matter for another debate.
3. It is harsh to say it will encourage dependency, because the NREGA allows for employment for only 100 days in a year, during the off-season when rural labourers would otherwise not have any employment. Putting greater purchasing power in the hands of rural labourers would greatly benefit the expansion of markets, because it is quite obvious that markets would not function when consumers have no real purchasing power.
4. Therefore, it is wrong to say that the opportunity cost of the NREGA is high, because we have no idea of what the future benefits are going to be from better infrastructure in the rural area and better purchasing power of rural households. These must be taken into account before you can make such sweeping generalizations regarding the opportuntiy cost.
5. I do not agree with your generalization that it would decrease aggregate income. That would be true if it diverts resources that are already being put in use. The NREGA is funded by the funds of the Central and State Governments, funds which are already captive and are not available to the private sector. Where does the question arise of decreasing aggregate income? OK, if these funds are used for productive activites in the industrial sector, then we can say that the rise in national income would be more than in the case of the NREGA. But it definitely would not decrease.
6. “Indians are poor because India’s aggregate production is inadequate and therefore the solution has to begin with increasing production.”
A dangerously reductive statement. This would be true of an economy characterized by a larger proportion of the employed (or employable) workforce dependent on the industrial sector. This is not the case in India. The NREGA takes the rural route because majority of our workforce is concentrated in that sector, from wage-labourers to marginal farmers whose lands are too unproductive to guarantee adequate incomes in the off-season.

Sorry for the long-winded (and late) submission on the issue. I would definitely love to hear what other readers have to say on the matter and the points I raised!